The American Giant Always Bounces Back

The new year has begun not with a whimper, but with a loud groan, emanating from Wall Street, economists rushing to revise their 2008 forecasts, and journalists competing for the front pages with scary stories about evicted homeowners sleeping rough, and consumers filing for bankruptcy. Country & western singer Kris Kristofferson did not have fallen chief executives and investment bankers in mind when he sang about the man who "once . . . had a future full of money, love, and dreams, which he spent like they was goin' out of style", but it is an apt description of many shell-shocked bankers and investors.

They have reason to worry. Oil finally hit $100 a barrel, sending share prices tumbling, gold prices soaring in anticipation of renewed inflation, and developing nations deeper into poverty. Rising food prices, combined with petrol prices that are due to break new records, are cutting consumer discretionary-spending power to a shadow of its former self. The unemployment rate last month shot up from 4.7% to 5%. America's manufacturing sector is slowing down, with sagging car sales a particular drag. One dealer is offering 12-year financing to people lusting after a Rolls-Royce.

Whether all this will produce a recession in 2008 remains less than certain. For one thing, the White House might step in with a fiscal stimulus package. Sources there tell me that the president is considering spurring economic growth by allowing faster write-offs of business investment, or, if Congress will wear it, lowering the rate of corporate tax. For another, we cannot be certain whether the Fed, now more worried that the slowdown might morph into a recession, will accelerate the pace of its rate cuts.

But there are some things we do know. Two forces have come together that will change the structure of the financial-services industry. The first is the need for many banks to rebuild their balance sheets by attracting equity capital; the second is the need for the sovereign wealth funds of oil-producing and other exporting nations to put their cash to work. The result has already been the purchase by these funds of important positions in Merrill Lynch, Citigroup, UBS and other banks. So far, the politicians have remained silent, lest they be accused of interfering with the inflow of desperately needed capital. That won't last.

We know, too, that as the greenback depreciates in value, foreign central banks are less and less inclined to keep stores of pictures of American presidents in their vaults, and more interested in diversifying their currency holdings. The dollar's share of central banks' holdings of foreign reserves has fallen from 66.5% to 63.8% in the past year. Equally important, oil-producing nations, which until now have accepted dollars-for-crude, and have pegged their currencies to the dollar, are finding it increasingly difficult to maintain those policies. The dollars Arabs use to pay the large foreign workforces on which their work-shy citizens rely, buy less and less when remitted to the wives and families of these workers. That is causing social discontent of the sort that horrifies the ruling classes in the Arab countries. My guess is they will begin pegging their own moneys to a basket of currencies that include the dollar, but in which the euro is importantly represented.

We know two other things. The first is that the American economy will indeed slow, at least in the first half of 2008 as the credit crunch, as it is oddly called given that banks are awash in cash, unwinds. The second is that America will elect a new president pledged to please not only the trade unions but a broad swathe of voter opinion by retreating from the nation's historic position in favour of free trade. Doha and other trade deals, if not already dead, will breathe their last, and be buried. The free flow of goods will be inhibited by increasingly protectionist measures, the free flow of capital will be threatened by greater scrutiny of the nontransparent sovereign wealth funds, and the free flow of labour made less free by more stringent border controls. Free trade, RIP.

These are all small things, compared with the really big thing we know. The American economy is an amazingly resilient and flexible machine. Remember the dotcom bust, which is cited as the model for what we are about to go through? Since that dreary period the American economy has added 8m jobs. In real, inflation-adjusted terms, the value of the goods and services produced in America is about 15% higher than during the dotcom bust. And even after the precipitous drops of recent days, the leading share-price indexes are healthily up over dotcom-bust levels: the Dow Jones and Standard & Poor's by about 70%, and the Nasdaq index of high-tech shares, although still far from its prebust high, by about 110%.

If you need any further proof of the ability of the American economy to survive and thrive after taking a blow, consider the speed with which output, employment and every other indicator rose soon after the devastating attack on September 11. Or after hurricane Katrina. Or ask yourselves whether you can identify the enduring impact of the following events during the Clinton years, now remembered as a golden age: the Mexican peso crisis, the Asian financial crisis and what scholars now call "the crisis of confidence and legitimacy of the international monetary and financial system".

It is fashionable to call the year just ended a year of two halves – a prosperous first half, followed by a sub-prime-infected second six months. This year might just prove to be the reverse: a stormy first half, followed by gradual brightening as America's entrepreneurs find new fields to conquer.